How Shadow Banks Rule the World

Nov. 18, 2012

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The man who is supposed to bring about the necessary change works in an office tower far away from major financial centers. When Svein Andresen broods over how he can best go about taming the wild masters of money, he sees the Black Forest through his office window. The level-headed Norwegian is the secretary general of the Financial Stability Board (FSB), which is housed at the Bank for International Settlements in Basel, Switzerland, the umbrella organization of the world's central banks.

The FSB is intended to avert a repeat of disasters like the 2008 crisis. "For years, governments and regulatory agencies paid too little attention to financial institutions outside the world of banking," says Andresen. Now he wants to bring order to the chaotic world of shadow banks. But it's a slow process.

Scant Information Poses Dilemma

In a few days, Andresen and his colleagues will present their proposals for new laws which they hope will be enacted worldwide. But then the political discussions will begin anew, and it will take until at least September 2013 before the new rules are in place.

At the moment, very little is known about many of the shadow companies. Precisely because they remained largely unregulated for so long, there is no government agency that could order them to provide information. "It's a classic chicken-and-egg problem," says Andresen. Without regulation there can be no data, and without data there can be no regulation.

Even the question of who should handle data collection in the future has triggered a dispute between politicians and regulators. It isn't easy to bring together opinions from the 20 countries whose governments meet regularly at the G-20 summits of leading industrial and emerging economies. To get the mammoth problem under control, FSB staff members have compiled a "world map of shadow banks," as Andresen calls the puzzle-like project.

Fifty different types of companies have been identified, and the FSB now intends to focus on the roughly 10 most common types. Regulators suspect that these companies alone have assets totalling $20 trillion.

But the more detailed the research is, the more difficult it gets. For instance, Germany's financial regulator BaFin called for the broad documentation and regulation of hedge funds, only to be blocked by Great Britain and the United States -- not surprisingly, given that many of these funds are headquartered in London and New York. Now only hedge funds that engage in real credit transactions will be subject to greater scrutiny in the future, a group that makes up less than a third of the industry.

Hedge fund manager Féry's business would likely be included. The Frenchman vehemently rejects being branded a reckless gambler, and he is not entirely wrong.

Shadow Banks Have Benefits
Unlike other hedge funds, says Féry, he works without outside credit. If money is lost, he explains, "only our reputation as manager and our end investors -- who know the risk we are taking -- are affected."

Even a regulator quietly admits that the most dangerous loan packages, which Féry buys from banks, among others, are in better hands at a hedge fund, because the deposits of bank customers are not being put at risk. "Those are the good sides of the shadow banking system." Féry also believes that small- and mid-sized companies in particular depend on his services because the banking crisis has forced them to "struggle for financing."